When a stock drops as dramatically as Rite-Aid (NYSE:RAD) stock has in the last few years, it’s tempting for investors to hunt for a bottom. The problem with bottom fishing is that things can get pretty cloudy. And this leads to investors seeing exactly what they want to see.
In the case of Rite-Aid, the company began an aggressive effort to cut operating expenses two years ago. As a result of this activity, the company boasted a surprisingly large earnings beat in their last quarter. But after RAD stock moved to over $20 per share, it has come back down to earth. Or is it just coming back to reality?
The answer really depends on the story you want to hear.
Rite-Aid Is Doing the Right Things
The old saying that when you’re trying to get out of a hole, the first step is to stop digging. So from that perspective, Rite-Aid is doing the right thing. Closing stores and selling others to Walgreens Boots Alliance (NASDAQ:WBA) are important first steps.
However, investors are going to have to be assured that the company’s latest earnings report is more than a sugar high. After all, it’s relatively easy to lose weight when you cut your food intake. But maintaining that over time is the trick. In order for RAD stock to support a significant valuation of above current levels will require the company to increase revenue. And that is where the story takes a different turn.
The Company Simply Does Not Have Enough Revenue
Normally when you see an earnings jump like the kind Rite-Aid posted you like to see revenue gains. But in the case of Rite-Aid, their revenue has largely been flat. In fact, per quarter revenue has stayed pretty much the same for the last two years. The company was quick to point out that it closed 62 stores in 2019, which may account for a good deal of the lost revenue.
But when I look on the other side of the company’s ledger, I see that Rite-Aid continues to burn through cash. In fairness, some of this has to do with a major renovation effort that Rite-Aid is doing in its existing stores. But the thing about renovation efforts is that you want to see sales increasing as a result of driving more foot traffic.
And in the company’s guidance following its earnings report, it is projecting overall revenue to remain flat in 2020 with same store sales expecting to increase in a range between 0% and 1%. While that may be sufficient to hold the stock near current levels, it doesn’t provide much reason for investors to get excited.
The Local Drugstore Has a Lot of Competition
But let’s look at a more fundamental problem. Rite-Aid is embracing Medicare Part D recipients. These customers will have a major impact on the company’s bottom line. But this is an extremely competitive market segment. On the one hand you have the continued success of the superstores such as Walmart (NYSE:WMT) that are giving seniors the ease and convenience of one-stop shopping. And then you have the ongoing trend towards home and curbside delivery.
Both of these are not easy headwinds for Rite-Aid to overcome without throwing more money at the problem. And the company is burning enough cash already.
Should You Buy or Sell RAD Stock?
Analysts are giving RAD stock a forward price target of $12. That’s below where the stock is selling today. Analysts also have a consensus sell rating on the stock. The company itself was looking to be acquired by Walgreens just a short time ago. Is that a cheap shot? Maybe. And the company has come out of that ordeal with more favorable pricing on its generic drugs. However, it also shows that the company itself was wary of its prospects of moving forward as a stand-alone entity.
But for Rite-Aid to get investors excited they will have to show that they can be a consistently profitable regional drug store chain. The company has posted negative earnings in five of its last eight quarters. And as my InvestorPlace colleague Mark Hake summed up last fall, “turnaround stocks rarely turn around.”
As of this writing, Chris Markoch did not hold a position in any of the aforementioned securities.
